Macro Vol Commentary
From start-to-finish, December was a fitting end to 2018. The S&P 500 experienced a 15.7% peak-to-trough decline followed by a nearly 7% rally to end the month. December was indicative of the increasing volatility in global markets that we experienced throughout 2018. The fundamental foundation of global markets has been fragile and remains vulnerable to policy mistakes. The change in sentiment has been abrupt with global concerns stemming from weakening macroeconomic conditions, global policy concerns, and reduced liquidity.
The fourth quarter stood in sharp contrast to the prolonged period of strong macroeconomic conditions, stable policy and excess liquidity that caused volatility to hit an all time low in 2017. The initial spark in February 2018 appeared to come and go without a trace as speculation of a purely technical move driven by volatility products was the most common narrative. The resurfacing of widespread volatility during the fourth quarter could not be so easily dismissed. The policy mistakes by the US, UK, Italy, Russia and Turkey exacerbated already fragile markets, culminating in a 3-day whirlwind on either side of Christmas sending the S&P 500 to YTD lows of 2351(-20% draw down peak-to-trough) and backup to 2500 just 2 days later. As a result, higher volatility across asset classes may be here to stay, which is not surprising when considering the excessive risk taking being unwound and a recoupling of asset prices with fundamentals taking place in the absence of the ‘Fed Put.’
Strikingly, despite arguably more consequential economic headwinds globally coming from Europe (domestic political uncertainties), China (slowing economic growth), Japan (prolonged stagnant economic growth) and cratering oil prices (lower export earnings and spending), December volatility in Europe, Asia and to a lesser extent Emerging Markets continue to lag what happened in the US to close out the year.
Cross-Asset Volatility Monitor
Based on investor feedback, we have decided to simplify our 20 asset volatility monitor to provide a more clear synopsis of the cross-asset volatility landscape. The new chart now shows the 1-month Volatility Risk Premium (“VRP”) alongwith the associated 1-Year Percentile of 1-month Implied Vol (“IV”). We believe this provides a more robust framework for explaining meaningful volatility market moves over the past month as well as a more intelligible monitor for identifying opportunities going forward.
Not surprisingly given the violent equity market swings in December, this month’s monitor shows numerous markets that have a meaningfully negative VRP. Specifically with respect to US equity markets, the negative VRP of SPX & RTY shows that domestic equities continue to be a leading indicator for global volatility in December while particularly Europe (SX5E, UKX) has held up well with a positive VRP despite very high IV levels. It should be noted that most measures of IV within global equities are near1y highs, which should be taken into consideration for long vol opportunities.
One theme that continues to carry over (albeit to a lesser extent) is the fact that some fixed income credit markets have thus far been protected from the pockets of volatility spikes that have run rampant over the other asset classes. You can see in underliers like TLT, LQD, FXB & FXA all have positive VRP and FXE has an abnormally low current implied vol (in the 24th Percentile) making these underliers key areas of interest for potential volatility opportunities should there be continued volatility contagion.
We remain cautious and defensive as we enter the new year, having multiple multi-sigma market moves in FX, Equities, Commodities and a pick-up in interest rate volatility in our immediate rear view mirror.
Important Disclosures and Definitions:
The viewpoints expressed in this report are solely those of Infinity Q Capital Management, LLC, (“Infinity Q”) and can change without notice.
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The indices and securities included in the Cross Asset 1-Month Probably Monitor are the 20 underlyings commonly assessed in reviewing the broad global volatility markets.
SPX Index: The S&P 500 Index is a capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.
SX5E Index: The EURO STOXX 50 is a stock index of Eurozone stocks designed by STOXX, an index provider owned by Deutsche Börse Group. According to STOXX, its goal is “to provide a blue-chip representation of Supersector leaders in the Eurozone.”
NDX Index: The Nasdaq-100 Index includes 100 of the largest domestic and international non-financial companies listed on The Nasdaq Stock Market based on market capitalization. The Index reflects companies across major industry groups including computer hardware and software, telecommunications, retail/wholesale trade and biotechnology.
UKX Index: The Financial Times Stock Exchange 100 Index, also called the FTSE 100 Index, is a capitalization-weighted index of the 100 most highly capitalized companies traded on the London Stock Exchange.
DAX Index: The Deutscher Aktienindex (German stock index) is a blue chip stock market index consisting of the 30 major German companies trading on the Frankfurt Stock Exchange
SMI Index: The Swiss Market Index is Switzerland’s blue-chip stock market index. It is made up of 20 of the largest and most liquid Swiss Performance Index (SPI) large- and mid-cap stocks.
AS51 Index: The S&P/ASX 200 measures the performance of the 200 largest index-eligible stocks listed on the ASX by float-adjusted market capitalization. It is considered the benchmark for Australian equity performance.
NKY Index: The Nikkei-225 Stock Average is a price-weighted average of 225 top-rated Japanese companies listed in the First Section of the Tokyo Stock Exchange.
HSI Index: The Hang Seng Index is a freefloat-adjusted market capitalization-weighted stock market index of the largest companies that trade on the Hong Kong Exchange, and is consider the main indicator of the overall market performance in Hong Kong.
Kospi2 Index: The KOSPI 200 Index is a capitalization-weighted index of 200 Korean stocks which make up 93% of the total market value of the Korea Stock Exchange.
FAANG: An acronym for the US equity market’s five most popular and best-performing tech stocks, namely Facebook, Apple, Amazon, Netflix and Alphabet’s Google.
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Past performance is no indication of future results.